Earnings season officially started this week as the big banks started releasing their quarterly reports. The numbers have been surprisingly good. Both revenue and earnings numbers have been strong.
The numbers that have been most interesting to us, however, have been the “provision for credit losses” numbers.
Provision for Credit Losses
You see, banks take risks every day when they issue loans to businesses and consumers. No matter how careful they are during the application process, banks know that some of those loans are not going to get paid back.
To account for this risk, banks set aside money that they can use to cover any potential losses they might suffer from delinquent loans. This money shows up on the bank’s financial statements as the “provision for credit losses.”
When the economy is doing well — or is anticipated to do well in the future — banks don’t set aside as much money. They believe businesses and consumers are more likely to stay current on their loans.
Conversely, when the economy is not doing well — or is anticipated not to do well in the future — banks set aside more money. Why? They believe businesses and consumers are more likely to default on their loans.
By watching these numbers, we can tell whether banks are confident in the health of the economy. This is an extremely useful indicator because banks have real-time loan-default data they are working with. Essentially, their finger is directly on the pulse of the U.S. economy.
So, what are the provision for credit losses numbers telling us this quarter?
Confidence at JPMorgan Chase
Looking at the numbers JPMorgan Chase put out in its quarterly earnings press release, you can see that the bank set aside much less money this quarter than it did last quarter — $611 million in the third quarter compared to more than $10 billion in the second.
In fact, JPM set aside less money this quarter than it did the same quarter one year ago. It set aside $611 million in the third quarter of 2020 compared to over $1.5 billion in the third quarter of 2019.
This tells us that JPM is confident the economy has halted its Covid-19 downslide and is likely to continue improving in the future.
Confidence at Goldman Sachs
Goldman Sachs appears to share JPM’s bullish outlook on the economy. Looking at the numbers GS put out in its quarterly earnings press release, you can see that the bank also set aside much less money this quarter than it did last quarter — $278 million in the third quarter compared to nearly $1.6 billion in the second.
And just like we saw with JPM, GS set aside less money this quarter than it did the same quarter one year ago. It set aside $278 million in the third quarter of 2020 compared to $291 million in the third quarter of 2019.
If GS were more concerned about the future of the U.S. economy, it would have set aside more money. But it hasn’t. This is good news for Wall Street.
The Bottom Line
We’ve been talking for weeks about the various election, fiscal stimulus and coronavirus related issues that could impact the U.S. economy, and we’re no more sure about how each one is going to play out than we were last week.
However, seeing the big banks not only proclaim confidence in the economic outlook for the United States but also “put their money where their mouths are” tells us that the uptrend in the stock market is likely to continue until something concrete happens to force it to do otherwise.
On the date of publication, John Jagerson and Wade Hansen did not hold (either directly or indirectly) any positions in the securities mentioned in this article.
John Jagerson & Wade Hansen are just two guys with a passion for helping investors gain confidence — and make bigger profits with options. In just 15 months, John & Wade achieved an amazing feat: 100 straight winners — making money on every single trade. If that sounds like a good strategy, go here to find out how they did it.
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